Loss of Business Income Due to the Governmental “Stay at Home” Orders Issued in Response to COVID-19 Was Not a Covered Loss

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In Mudpie Inc. v. Travelers Casualty Insurance Company of America (No. 20-16858, filed October 1, 2021 ord. certified for publication October 4, 2021.), Mudpie Inc., a retailer of children’s products in San Francisco, filed a claim under its Travelers policy’s “Business Income” and Extra Expense” coverages contending that state and local “Shelter in Place” orders issued in response to the COVID-19 pandemic prevented it from operating its store.

The policy covered, “physical loss or damage to [Mudpie’s] Covered Property…caused by or resulting from a Covered Cause of Loss.”

The policy’s Business Income coverage in pertinent part provided “[Travelers] will pay for the actual loss of Business Income [Mudpie] sustain[s] due to the necessary ‘suspension’ of [Mudpie’s] ‘operations’ during the ‘period of restoration.’ The ‘suspension’ must be caused by direct physical loss of or damage to property at the described premises. The loss or damage must be caused by or result from a Covered Cause of Loss….”

Likewise the Extra Expense coverage provided, “[Travelers] will also pay Extra Expense (including expediting Expenses) to repair or replace the property, but only to the extent it reduces the amount of loss that otherwise would have been payable under [the ‘Business Income’ provision].”

Travelers denied the claim finding that the policy’s Business Income and Extra Expense coverage did not apply because the limitations on Mudpie’s business operations were the result of the state and local governmental “Stay at Home” orders as opposed to “direct physical loss or damage to property at the described premises.” Travelers also cited the policy’s Virus Exclusion precluding coverage for “loss or damage caused by or resulting from any virus.”

Mudpie subsequently filed suit on behalf of itself and a putative class of all retailers in California that purchased comprehensive business insurance coverage from Travelers which included business interruption coverage, and that had filed a claim for loss of business income following California’s “Stay at Home” Order and were subsequently denied coverage.

Mudpies’s complaint advanced three causes of action; 1) declaratory relief that its business income losses were covered and not precluded by exclusions or other limitations in the policy; 2) breach of contract; and 3) breach of the implied covenant of good faith and fair dealing.

Travelers filed a motion to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) contending Mudpie was not entitled to Business Income or Extra Expense coverage because Mudpie had not set forth any facts demonstrating that it suffered direct physical loss of or damage to insured property and because the policy’s Virus Exclusion precluded coverage. In its opposition, Mudpie countered that its inability to operate and occupy its storefront in compliance with the government orders constituted a direct physical loss of property covered by the policy.

The District Court granted Travelers’ motion finding Mudpie failed to allege “any intervening physical force beyond the government closure orders” and thus was not entitled to Business Income or Extra Expense coverage under the policy. The District Court declined to consider Travelers’ contention that the Virus Exclusion barred recovery. The District Court dismissed the complaint without prejudice and gave Mudpie leave to amend. Mudpie filed a notice advising it would not be amending its complaint. The Court dismissed the complaint with prejudice and Mudpie appealed.

The Ninth Circuit affirmed the District Court’s ruling that Mudpie’s claimed losses were not covered under the Traveler’s policy and that the District Court did not err by dismissing Mudpie’s complaint. Further, the Court of Appeals concluded the policy’s Virus Exclusion barred coverage for the claimed losses.

The Court of Appeals began its analysis of whether Mudpie alleged a “direct physical loss of or damage to” its covered property by examining how other California courts interpreted coverage provisions similar to the Travelers policy’s “direct physical loss of or damage to property” language.

The Ninth Circuit looked to the California Court of Appeal’s interpretation of the phrase “direct physical loss” in a business insurance policy in the matter of MRI Healthcare Ctr. of Glendale, Inc. v. State Farm Gen. Ins. Co., 115 Cal. Rptr.3d 36, 31-32 which held that “ ‘direct physical loss’ contemplates an actual change in insured property… occasioned by accident or other fortuitous event directly upon the property causing it to become unsatisfactory.” The opinion in MRI Healthcare further held, “for loss to be covered, there must be distinct, demonstrable, physical alteration’ of the property.”

Citing Hughes v. Potomac Insurance Co. of the District of Columbia, Mudpie contended that under California law “direct physical loss of or damage to the property” merely requires that the property no longer be suitable for its intended purpose.

The Ninth Circuit rejected Mudpie’s argument first distinguishing Hughes noting that it did not interpret a “direct physical loss provision” like the one at-issue in the Travelers policy and instead interpreted the term “dwelling” as used in a homeowner’s insurance policy. The Ninth Circuit further noted, the opinion in Hughes did not imply that an insured need not show physical change to the insured property to provide “direct physical loss” and to the contrary the court in Hughes concluded that the insured’s home sustained “real and severe damage when the soil beneath it slid away and left it overhanging a 30-foot cliff” and deemed the house uninhabitable.

Quoting MRI Healthcare, the Ninth Circuit emphasized that Mudpie’s complaint did not identify a “distinct, demonstrable, physical alteration of the property” and further did not allege that Mudpie was permanently dispossessed of its property. The Ninth Circuit characterized Mudpies’ argument as urging it to interpret “direct physical loss of or damage to” to be synonymous with “loss of use.” The Court of Appeals declined Mudpie’s proffered interpretation, reasoning that California courts had carefully distinguished “intangible,” “incorporeal” and “economic” losses from “physical” losses citing Doyle v. Fireman’s Fund Ins. Co. (2018), 229 Cal. Rptr. 3d 840, 843-44 and Ward Gen. Ins. Servs., Inc. v. Emos. Fire Ins. Co. (2003), 7 Cal. Rptr. 3d 844 851.

Looking at the Travelers policy as a whole, the Ninth Circuit determined that its interpretation of the phrase “direct physical loss of or damage to” as requiring physical alteration of the property was consistent with the policy’s other provisions. Supporting this analysis, the Ninth Circuit noted that the policy provides coverage for Business Income and Extra Expense only during the “period of restoration” which suggests the policy contemplated providing coverage only if there are physical alterations to the property and that any interpretation that the policy provided coverage absent physical damage would render the “period of restoration” clause redundant.

The Ninth Circuit then expanded its analysis and chronicled decisions rendered by a multitude of other courts across the nation which interpreted the same or similar language of business income provisions and their application to losses sustained by businesses as a result of COVID-19 governmental shut down orders. Each opinion examined by the court’s analysis held that physical alteration, loss or damage to the insured property was necessary for the invocation of a business income provision such as the one at-issue.

Finally, the Ninth Circuit found that Mudpie’s claimed losses were also excluded from coverage pursuant to the policy’s Virus Exclusion policy which provides, “[Travelers] will not pay for loss or damage caused by or resulting from any virus, bacterium or other microorganisms that induces or is capable of inducing physical distress, illness or disease.”

On appeal, Mudpie argued that its losses were caused by the governmental orders and not directly by the COVID-19 virus. Travelers countered that the COVID-19 virus prompted state and local authorities to issue the “Stay at Home” orders and as such the Virus Exclusion applies.

The Court of Appeals noted California courts’ broad interpretation of the term “resulting from” in insurance contracts and noted California had adopted the efficient proximate cause doctrine in Sabella v. Wisler, (1963) 377 P.2d 889, 895 which provides, “where there is a concurrence of different causes, the efficient cause—the one that sets the others in motion—is the cause to which the loss is attributed, though the other causes may follow it, and operate more immediately in producing the disaster.”

The Ninth Circuit reasoned that because Mudpie’s complaint did not allege an attenuated causal chain between the COVID-19 virus and its losses, and because Mudpie did not dispute that governmental “Stay at Home” orders were issued in response to the COVID-19 pandemic, Mudpie could not plausibly allege that the “efficient cause was anything other than the spread of the virus or that it was a merely a remote cause of its losses.

This document is intended to provide you with information about insurance law related developments. The contents of this document are not intended to provide specific legal advice. If you have questions about the contents of this alert, please contact the authors. This communication may be considered advertising in some jurisdictions.

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